Singed but not burnt, India must learn from others’ mistakes

Storms don’t happen in wells, said economist Lord Meghnad Desai, in the course of a particularly lively sally during Mint’s Clarity Through Debate (CTD) event on The Financial Crisis: Lessons For India.

Desai was arguing that India would have been better off if it had freed up its financial sector enough to have its own crisis, instead of not having done so. Had this (the freeing up) happened, he said, the country would have probably had fewer poor people than it does now.

Desai’s was only one of the provocative voices at the debate, which attracted an audience of about 200 senior executives from banks and finance firms. Defending India’s approach staunchly was M. Damodaran, former head of India’s stock market regulator who has also previously been head of the country’s largest mutual fund company. And pushing the country to do more on the financial reforms front was Naina Lal Kidwai, head of the local unit of UK-based bank HSBC Holdings Plc.Chanda Kochhar, joint managing director of ICICI Bank Ltd, India’s largest private lender, O.P. Bhatt, chairman of State Bank of India, the country’s largest bank, and K.C. Chakrabarty, chairman and managing director of Punjab National Bank, also took part in the debate. Mint presents edited excerpts from the discussion, which was moderated by Tamal Bandyopadhyay, deputy managing editor, Mint.

Is there anything the rest of the world can learn from India? And what are the lessons we learnt from the crisis?

Chakrabarty: All financial crises (take place) because money is borrowed in excess and used badly...Excess liquidity should be avoided, excess complicity in financial products should be avoided and excess greed should be avoided. I would say we are less greedy because our (bankers’) salaries are not linked to (banks’) profitability. We also must learn (that a) market-determined financial system is not a solution to removing global disparity. Because the market-determined financial system has one fallacy—capitalize the profit and socialize the loss. While too much governance is bad, too much (of an) unsettled market is also bad.

Kidwai: I think one of the key lessons that we have learnt is that there is nothing like traditional banking. You have to know who you are lending to and not get carried away packaging products...The lesson that we all have to now raise across the world is really to get back to what banking is all about—that is, knowing your customer. In knowing your customer, you are able to work with the customer, to restructure, to recover your loan and, even better, reach a variety of people. (For example,) where credit cards have done well is where the card is anchored in a relationship. Where it stands as a product on its own, it is prone to actually get distressed and run into trouble.

Kochhar: I think whether a bank or a country, nobody can remain isolated from whatever happened globally. Everyone has to go through that and I think, in a way, India is also facing a fallout of what happened globally. So the lessons from India, in my view, are two. On the banking practices per se, or lending practices per se, I think we have to remember that our lending practices have been basic banking. That is, you go through a customer’s cash flow—whether it is an individual or a corporate customer—and lend only on the basis of the ability of the customer. Unlike what the banks did in the Western countries, where too much money has been lent at attractive rates...not realizing that some customers don’t have the ability to pay. And that was something the banking sector in India did not do. One more thing that has helped India is that the banks are very low leveraged and the extent of that dependence really determines how fast a nation will bounce back. We all know that our dependence on the outside world is less, and that gives us the resilience to bounce back at a momentum faster than many other nations.

Damodaran: I think what we need to do is to forget words such as crisis, recession and over-regulation... We should take out those words from our vocabulary; we are much better off than most of the countries. Everything in life is relative. It’s true you can take the position (that) you haven’t seen the worst of it yet. But even the worst is nowhere close to what some have already seen and are likely to see going forward. I think what happened in developed countries is that there was an invitation to disaster. If you had seen the hoardings of some of the home loan products, they said very clearly that if you did not have the income, if you did not have a job, if you did not have anything at all, you are (still) welcome to avail the housing loan. They said these in so many words. So I don’t know why they are complaining when things went wrong.

I think what we have done several years ago has turned out to be right—significant ownership of the public sector of the banking sector... Clearly there is a role for government and that is being painfully recognized by some countries in other countries... Clearly it is recognized that markets playing god is not a solution. These are lessons we learnt some time ago. We have had distinguished economists...who recommended much the same thing (to India) that brought the Western world to its knees. But we were so slow in implementing some of them that the crisis came elsewhere before we could do things on our own and, therefore, I think the slow ponderous pace at which we actually do things helped to save us.

Bhatt: The lesson to be learnt from India is that each country has its own ethos, each country has its own structural strength or limitation, each country brings a certain place in the path of development and what is appropriate for one may not be appropriate for another.

And how do you therefore discriminate between what is good for you and what is not good for you? It is a matter for judgement and there are people whose job it is to make that judgement. The other lesson is this whole issue of incentivization. It is said the public sector is immune from incentivization but despite that somehow it continues to perform well. And I dare say that in many instances, many parameters which we can take from the financial services sector, public sector banks actually outperform both foreign banks as well as private sector banks.

Now how is it possible? What are appropriate incentivization structures? Is it possible to have a scheme of group incentivization, social incentivization, integral incentivization, appropriate incentivization? …Is it possible that by introducing the kind of incentivization that is there in other sectors in India and in foreign countries, whether I would be destroying the culture of the bank which actually is the strength of the bank?

I think a time has come when the entire world is in crisis, and there are millions that have lost homes and jobs, people who don’t have food, people who don’t have a future to look forward to...There is not enough of anything. It is the chasing the mirage that has created the kind of problem we are in.

Desai: Let me start with a cockney expression—while we felt sad the entire world has suffered so much, India has not—I would say ‘you should be so lucky.’ India has not suffered because India has not done anything. there is an expression in Sanskrit called “kupamanduk”. If you are a little frog in the well, you are very happy, you think the world is the well. and storms don’t happen. Of course storms don’t happen. Storms don’t happen in the wells.

India has this amazing capacity for smugness, which astonishes me again and again … for 40 years, India grew at one of the slowest paces humanly possible to grow—1% per annum.. India is still growing slowly. Because you have decided on great principles and philosophies to grow slowly. People decided not to pay the price for slow growth.

The stakeholders of the financial system (in the developed countries) go out—crash. But they will dust themselves and stand up and will resume growth. India should not from this experience conclude that what it is doing is the right thing. India should conclude that there is still a long distance in this covered banking system. There’s a vast distance between having an efficient banking system that actually does traditional banking which, I can tell you, Indian banking system does not do.

Countries grow by crisis. If you don’t have a crisis, you won’t have growth. I feel what India should do right now is that there are good things, good opportunities to grow right now. I think india’a public sector banking system is very backward. I think KYC stands for “kick your customer”.

I know it will hurt, but Pakistan has lower poverty than India, Pakistan has lower inequality than India, and Pakistan until 5 years ago had higher per capita income than India. Having said that, I believe India is capable of much better and a couple of crises won’t hurt. And if you don’t want crisis, you don’t get growth.

Should the financial sector be opened up in India, allowing more competition from foreign banks?

Damodaran: Let’s start with what you raised. It’s not about keeping the doors closed for foreign banks. Until now foreign banks have been allowed to increase their presence in India by opening more branches.

A few years ago, a decision was taken that they could set up their own holding companies, but they just wanted to pick up small private sector banks cheap and they wanted that and nothing else. Now, if you...seek a branch licence in the US, ask her what pain you go through to get a licence there. How can one set of rules apply for the US and another set apply for India? If you practice reciprocity and non-discrimination...any country that closes its doors on your banks should not find the doors here open. I think we should conduct all of this from a position of strength and self-respect rather than being people that others use as doormats or carpet to walk on... It’s not our case that we are absolutely happy with the situation in India, it’s not the case that we don’t need to think a little faster, a little better, do some other things more differently, I think if you look at the model that has failed elsewhere and the model that is underperforming in India, my question to you would be “would you rather have underperformance or crisis”? I would have underperformance.

You used the expression “These people dust themselves and they get up” I think in the process of dusting and getting up, the poorer people will remain on the ground and the richer giants will get up and the inequalities will surface—that’s what you are going to see. You will see a whole lot of poor people who will get even more marginalized.

Couple of other quick thoughts. I’m not for a moment saying that we should close our doors, it’s not as if our doors are fully closed at this point of time, clearly we should open doors not from a position of weakness. ‘We need you therefore come in’. No. ‘We are strong enough and we will be able to absorb you in our system from a position of strength.’

Kidwai: I would like to lend my voice to what Meghnad is saying, in that we must look at the structure of the banking sector and does it fulfil what we need as a country? The truth here is we still do not have financial inclusion And that, at this stage of India’s growth and independence, can’t be something we can be proud of. That applies to all of us in the banking fraternity, foreign banks wanting to go into rural.., banks that are already rural being too frightened to do more there, and indeed the whole nexus of politicians and lending, which has brought a bad name to agricultural loans..

Why is that we, who are so proud of our best and brightest, still don’t have a major bank in the (world’s) top 50. So it really comes down to softly, riskless, plodding-along approach, somewhere along the line is not doing us right. The worst takeaway from the financial crisis is ‘oh you got it right, frog in a well, and being very happy being in the well and we really don’t want to get out and join the world out there.’ What’s going to happen as a result is the world will pass us by yet again, as it did when India shut itself out.

Chakrabarty: The debate that we are making is that whether we will open up. We are already opened up. Two-three issues – opening up would make the life of customers better – that is I think not going to happen. When financial sector reforms were introduced, private sector banks were given a better role, foreign banks were given a better role. Now that should have brought the competition in the market place and that should have lowered the lending rates. Today the prime lending rate of the foreign banks are the highest. Prime lending rates of the private banks are the highest. If you say reform, competition will make the customers life better, it has not happened in this country.

Kochhar: See opening up and bringing in competition in any sector helps because it brings in efficiency.

Even when, during the talk of opening up for private sector banks, I think the big change that happened in India was that it was at that time that the retail customers found loans becoming affordable and the whole consumption growth of India was in a way capitalized by the retail finance growth that happened in the country at that time. So I think opening up brings in a lot of efficiency; it also helps existing players to shape up but what we have to remember is that for foreign entities India is open in almost all ways. The foreign banks have been in existence in the country for decades, all the rules that apply to Indian banks apply to foreign banks, whether it licensing of branches, whether it for any other stipulations ..The only thing that was restricted for a foreign bank is to come and buy an existing bank. ..Now what we have to look at is whether opening up and not going forward is a strong concept of reciprocation. We have to recognize that we are open at a certain level and there are countries that are much less open as compared to us. There are countries like UK who are very open. There some countries, which are open, but a foreign bank branch cannot connect to the ATM network of the country, where as when we give branch license for foreign banks, the branch can connect to the entire ATM network in the country.

Kidwai: I am glad you made that (point), Chanda. We are a UK bank … and by your own definition the UK is entirely open. I can tell you we stand in line, begging with a bowl, for getting more branches. 155 years in the country and 47 branches .. we have just been given three more. 50 branches to show for the 155 years here. That is not as reciprocal as the UK has been …

Bhatt: I am all in favour of opening up of the system to foreign banks. I believe opening up of the economy and bringing in competition is good....But there is a pace at which competition should be allowed. PSU banks were nationalized in 1969, the reason was that the government wanted to use the banks as an instrument of public policy for socioeconomic development. And this has been successful through priority sector lending and all kinds of developments.

Definitely it is the time to revisit (banking policy to foreign banks). Whether it will be for opening up or not, I don’t know. But definitely given the state of the world, it’s time to revisit. Actually it is time to open up the economy. We need capital, we need technology, we need expertise...(we?need)?$500?billion in the infrastructure sector. If foreign banks (are) allowed to come, I am sure they will help in boosting the infrastructure sector.

Desai: Even after 40 years of nationalization they have not reached the poorest of people, forget about being in the top 50. It all shows that they are idle, bureaucratic public sector banks. Their growth just at the pace of total GDP is not a miracle.

Damodaran: I think we need incremental steps to get us there and see that we don’t trip and fall over and pay the price that other countries have paid in the process of opening up.

Kidwai: I think the economy is now worse off today than what we were looking at when we were looking at capital account convertibility. The fiscal deficit at 10% and in our estimate at even 14% is something to be watched. As long as the government borrows the way it does and fisc remains the way it is, I don’t believe there is any scope of convertibility

Bhatt: We need to have our own model and we have to know what is the objective of currency convertibility... It is also true that over a period of time, there has been enough relaxation in rupee convertibility. Today there are multiple reason for which foreign currency can come to India and all (can) repatriate back profits, dividends... Today any individual can invest up to $200,000 per head, per year and for those things that you have to go to the Reserve Bank of India, I am yet to hear a case where the Reserve Bank of India has said no.

Chakrabarty: If you see the basic reasons for this financial meltdown, you will see that there was a big black hole in the regulation of the over-the-counter market. This is the market which can be manipulated very easily. If you see the financial derivatives and all such products, you will understand it can be easily manipulated. Unless there is a competent regulator of this market, opening up will be very dangerous.

After this meltdown, do we say no to innovation, risk-taking?

Kochhar: There can never be a stoppage to innovation. In fact in a challenging environment, you need more innovation.

Not just the banking sector, but the country as a whole we have to see can we innovate effective business models, become more efficient and innovate new ways of doing businesses so that we become more competitive.

Chakrabarty: When we are talking about innovation, I think we should make a difference between innovation and violation. Because there is a very thin line of differentiation. Because there is a very thin line (between) financial innovation and financial engineering. Again the lesson from the meltdown is that financial engineering cannot bring perpetual prosperity.

Bhatt: As Dr Chakrabarty said, not financial engineering. Especially at a time like this when there is huge uncertainty, when there is huge volatility, when people are getting scared, but nobody is trying to understand the reasons for this volatility.

Desai: Of course we should have innovation. India has had a riskless banking system with subsidised capital given by the government to the public sector banking. It gives them a cushion. Which is why there is no Indian bank in the top ten whereas Chinese banks are.

Damodaran: ...We must have innovation. Because innovation is what distinguishes god’s highest creation from the rest.